Forex Walkthrough

AAA

Level 4 Charts - Bollinger Bands®

Bollinger Bands® are a technical chart indicator popular among traders across several financial markets. On a chart, Bollinger Bands® are two "bands" that sandwich the market price. Many traders use them primarily to determine overbought and oversold levels. One common strategy is to sell when the price touches the upper Bollinger Band® and buy when it hits the lower Bollinger Band®. This technique generally works well in markets that bounce around in a consistent range, also called range-bound markets. In this type of market, the price bounces off the Bollinger Bands® like a ball bouncing between two walls.



Figure 1


Even though prices may sometimes bounce between Bollinger Bands®, the bands should not be viewed as signals to buy or sell, but rather as a "tag". As John Bollinger was first to acknowledge, "tags of the bands are just that - tags, not signals. A tag of the upper Bollinger Band® is not by itself a sell signal. A tag of the lower Bollinger Band® is not by itself a buy signal." Price often can and does "walk the band". In those instances, traders who keep trying to sell when the upper band is hit or buying when the lower band is hit will face an excruciating series of stop-outs or worse, an ever-increasing floating loss as price moves further and further away from the original entry point. Take a look at the example below of a price walking the band. If a trader had sold the first time the upper Bollinger Band® was tagged, he would have been deep in the red.


Figure 2


Perhaps a better way to trade with Bollinger Bands® is to use them to gauge trends.

Using Bollinger Bands® to Indentify a Trend
One common cliché in trading is that prices range 80% of the time. There is a good deal of truth to this statement since markets mostly consolidate as bulls and bears battle for supremacy. Market trends are rare, which is why trading them is not nearly as easy as one might think. Looking at price this way we can then define trend as a deviation from the norm (range).



At the core, Bollinger Bands® measure and depict the deviation or volatility of the price. This is the reason why they can be very helpful in identifying a trend. Using two sets of Bollinger Bands® - one generated using the parameter of "1 standard deviation" and the other using the typical setting of "2 standard deviation" - can help us look at price in a different way.

In the chart below we see that whenever the price channels between the two upper Bollinger Bands® (+1 SD and +2 SD away from mean) the trend is up. Therefore, we can define the area between those two bands as the "buy zone". Conversely, if price channels within the two lower Bollinger Bands® (–1 SD and –2 SD), then it is in the "sell zone". Finally, if price wanders around between +1 SD band and –1 SD band, it is basically in a neutral area, and we can say that it's in "no man's land".

Another great advantage of Bollinger Bands® is that they adjust dynamically as volatility increases and decreases. As a result, the Bollinger Bands® automatically expand and contract in sync with price action, creating an accurate trending envelope.



Figure 3


Conclusion
As one the most popular trading indicators, Bollinger Bands® have become a crucial tool to many technical analysts. By improving their functionality through the use of two sets of Bollinger Bands®, traders can achieve a greater level of analytical sophistication using this simple and elegant tool for trending. There are also numerous different ways to set up the Bollinger Band® channels; the method we described here is one of the most common ways. While Bollinger Bands® can help identify a trend, in the next section we'll look at the MACD indicator which can be used to gauge the strength of a trend. (To look at other types of bands and channels, take a look at Capture Profits Using Bands And Channels.)

MACD


Related Articles
  1. Forex Education

    Using Bollinger Band® "Bands" To Gauge Trends

    Find out how this smart tool can help you achieve superior analysis.
  2. Investing

    The Right Way To Trade Bollinger Bands

    As the inventor of Bollinger Bands®, analyst John Bollinger discusses some of the misconceptions about trading the bands and how using them on multiple time frames can be advantageous.
  3. Technical Indicators

    Organize Price-Band Relationships In Bollinger Bands®

    Bollinger Bands have become an enormously popular market tool since the 1990s but most traders fail to tap its true potential.
  4. Trading Strategies

    Understanding Bollinger Bands

    In the 1980s, John Bollinger developed the technique of using a moving average with two trading bands above and below it. Learn how this indicator works, and how you can apply it to your trading. ...
  5. Technical Indicators

    Trade This High Probability Bollinger Band Pattern (INTC, YHOO)

    Bollinger Band box patterns set up profitable opportunities when trends give way to well organized trading ranges.
  6. Active Trading

    Enter Profitable Territory With Average True Range

    Find entry or exit signals or develop a complete system based on this versatile tool.
  7. Technical Indicators

    How To Apply Bollinger Bands® With Metatrader 4

    Learn how to use one of the most popular technical indicators in the MT4 trading platform.
  8. Forex Education

    Capture Profits Using Bands And Channels

    Donchian channels, Keltner channels and STARC bands are not as well known as Bollinger bands, but they offer comparable opportunities.
  9. Technical Indicators

    The Top Technical Indicators For Commodities Investing

    Traders can use "the usual suspects" (standard indicators for trend trading) when it comes to choosing indicators for investing in commodities. Here's how.
  10. Forex Education

    Trading Double Tops And Double Bottoms

    We look at how Bollinger Bands help accurately project entry and exit points for pattern traders.
RELATED TERMS
  1. Bollinger Band®

    A band plotted two standard deviations away from a simple moving ...
  2. Technical Indicator

    Any class of metrics whose value is derived from generic price ...
  3. STARC Bands

    A type of technical indicator that is created by plotting two ...
  4. Turtle Channel

    A trading band created by plotting the highest and lowest prices ...
  5. Unique Indicator

    A technical indicator that can be developed using only core elements ...
  6. Price Band

    A value-setting method in which a seller indicates an upper and ...
RELATED FAQS
  1. Are Bollinger Bands® useful for analyzing securities with very low volatility?

    Learn more about Bollinger Bands, a tool based on standard deviations of moving average that can be applied to both high ... Read Answer >>
  2. How are Bollinger Bands® used in forex trading?

    Use Bollinger Bands in forex trading to identify entry and exit points with ranging trends or to spot increasing volatility ... Read Answer >>
  3. Are Bollinger Bands® useful for analyzing highly volatile securities?

    Discover how the dynamic nature of Bollinger Bands makes them a very useful indicator for securities that have historically ... Read Answer >>
  4. Are Bollinger Bands® used for investing or trading?

    Find out how investors or traders would use Bollinger Bands and why they are more useful for technical traders than long-term ... Read Answer >>
  5. What is the logic behind using Bollinger Bands® as an indicator of volatility?

    Discover the logic behind using Bollinger Bands as a measure of price volatility for a security, and how the bands adapt ... Read Answer >>
  6. How can I use Bollinger Bands® to spot options trading opportunities?

    Learn about different strategies using Bollinger Bands, and understand how the Bollinger Band is calculated using standard ... Read Answer >>
Hot Definitions
  1. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  2. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  3. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  4. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  5. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  6. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
Trading Center